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Andrés Velasco, a former presidential candidate and finance minister of Chile, is the author of numerous books and papers on international economics and development. He has served on the faculty at Harvard, Columbia, and New York Universities.

We have carefully read the interesting Article of Andrés Velasco about the challenges that the Chilean pension system is facing as a consequence of the increase of life expectancy and the maintenance of pension age for more than 35 years, what have also extended the time period of pension reception. In addition to the latter, interest rates have significantly decreased worldwide.

We agree with most of what was stated in said article. Nevertheless, it called our attention the paragraph that affirms that the problem of pension fund return is aggravated by the high fees charged by the pension fund administrators (AFP). It states that a "commission appointed by the government (Bravo Commission) have recently arrived to the conclusion that administrators have generated high real returns for pension fund investments (an annual real average return of 8.6% for the period 1981-2013), but the increased administration fees reduced returns to approximately 3% real per year for the same period ".

In this regard we would like to confirm that for the abovementioned period the pension funds investment return was indeed high and reached an 8.6% per year above the inflation. However, the calculation of the fees' net return is wrong, as it was also mentioned by some outstanding members of the Bravo Commission.

According to the Law, the mandatory saving administration fee is only charged once at the moment of paying the contributions as a % of the remuneration and is deducted from it and not from the cumulated savings. In other words, every contribution pays a fee only once in exchange for the AFP to administer said contributions and the individual accounts until the workers retire. In fact, a worker that stops paying contributions does not pay fees, but the AFPs continue to administer their individual accounts. For that reason, the calculation of the fees' net profitability using the IRR (Internal Return Rate) methodology should consider the complete labor cycle.

Unfortunately, the methodology used for calculating the abovementioned 3% has not been disseminated. Nevertheless, the limited information available suggests that it has serious methodological errors, one of which is calculating IRR considering only one part of the period in which the AFPs administered the individual funds and invested the affiliates' pension funds and not the worker's whole life, what makes the net profitability to be significantly underestimated.

On the other hand, a company specialized in pension funds, PrimAmérica Consultores, made an estimation of said return based on the IRR methodology using official information from the Office of the Superintendent of Pensions and, of course, including the biases previously explained, since it only considered one part of the labor cycle. It concluded that between 1981 and 2014 the average IRR of the individual accounts was a real annual 5.9% gross of fees and a real annual 4.7% after fees, figures that are significantly higher than those mentioned in the article.

Moreover, this calculation is an average that mixes members with different labor histories, what also implies very different returns among them. By way of example, consider those persons that paid contributions for some period of time, but for different reasons stopped paying and whom the AFP is not charging fees but continue administering their balances in their individual accounts. The fees' net return of these affiliates is higher than those obtained by those who regularly pay their contributions during their labor life and pay fees every time.

Another statement of Mr. Velasco that could lead to inappropriate conclusions is the insinuation that high fees reduce real profitability in 5.6 percentage points, i.e. from an 8.6% to a 3.0%. In this regard, from the information provided by the Office of the Superintendent of Pensions it is concluded that the fees received by the AFPs have been almost a 0.6% of the pension funds during the last five years and are considerably lower than the average fees charged in the pension programs of the OECD countries.

Based on the aforementioned, FIAP is aware of the need of improvement of the second contributive mandatory pillar of the individually-funded accounts in Chile, but improvements should be performed based on a wide technical discussion, analyzing the best proposals for the integral reform of the pension system, in order to warrant it to have a wide coverage, to provide appropriate pensions for the workers, to be fair and financially sustainable.

Guillermo Arthur
President
International Federation of Pension Fund Administrators (FIAP)

Key lesson: In order to make private pension funds appealing, Chile has tricked its population to think a 10% savings rate would be enough, when its common sense that that rate has to be on the 25%- 30% level

Andrés Velasco is one of the few people that's worth listening to in Chile. Since our level of intellectuals and the discussion we often see and hear are declining considerably. Still, I think there are other discussions that nobody has put on the table and I consider this much more relevant than changing the pension system.
Apart of sharing risk between pension funds (AFP's) and workers which is a must, we should think of adding more restrictions to who can borrow from this funds in order to create better incentives. In Chile the biggest companies, which are the once who pay the lowest salaries and delay payments to suppliers to more than 150 days and later offer to buy their same debt at a discount (factoring) are the once who benefit the most from this huge pull of money, which Andrés mentioned as USD$150 Billion. On one end this corporations benefit themselves from the savings of employees and hurt them and small businesses with low salaries and delay payments, thus hurting employment and the much needed continuity of savings into the pension funds, which later reflectes as lower pensions.
My proposals are this, companies that borrow money from pension funds must:
- Pay wages above minimum.
- Return to pay unlimited 1 month salary per annum of service after firing an employee (which was lobbied out more than a decade ago). This will work as an unemployment insurance and part of that money can be used to avoid gaps in the employees contributions.
- They should be forbidden to delay payment to suppliers and of course to buy their own debt back through "Factoring".
- This companies should be unable to declare profits or pay dividends until they have increase their minimum wages to a certain level above the minimum, called it "sensible minimum wage".
- Banks should be forbidden to lend money they got from this funds at more than a minimum management fee. They should be used as a tool the allow workers to access credit and not as a money machine that lend workers savings at interests of up to 40%. This is a disgrace and should be regulated immediately.
This are a few measures that should be in discussion but they are not. In Chile more than modifying the pension fund system we must improve labor laws and abuses from the biggest companies, which at the end hurt society a whole and increase the gap between haves and have not.

1997 in an Op-Ed I wrote: “For over ten years I have been enthusiastic about the pension funds in Chile… Why am I now concerned… Until when will we have to listen to siren songs about possible real returns?”

And in “Voice and Noise” 2006: “Any individual Social Security accumulation system that has the luck to start when the markets are close to rock bottom will always perform better than those systems that start when the markets are at the top. This has been the real beginner luck of the Chilean system. Future generations of Chilean accumulators might not be as happy with the results as the pioneers were.”

Fall in pensions for whatever reason does not constitute fall in resources, which would pensioners be normally consuming, if there would be no fall in pensions. These capacities, natural resources, services, human work bind to them are still waiting to be used

Impact of pensions on unemployment
http://genomofcapitalism.com/index.php/4-3-impact-of-pensions-on-unemployment-2